The housing market

UK Households

UK Dwellings

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In the early 20th Century, less than 10% of all
homes were owner-occupied, but by the early 21st Century, this figure
had risen to 70% - just above the EU average. By 2010,
there were 21 million households in the UK.

(Source: ONS 2011).

In the UK, privately owned
property is either freehold or leasehold. Freehold ownership
means that the land is owned as well as the property on the land, and
leasehold means the land is not owned, and the owner buys the right
to use the land and property for a period of time, usually over 100
years when the lease is first granted. As each year goes by, the lease
becomes shorter until the land and property reverts to the landlord. It
is common for leaseholders to purchase an extension to the lease when it
falls below 60 years.

Mortgages

The majority of freehold and leasehold property is bought with the aid
of a long-term loan, called a mortgage. Mortgages can be for any period
of time, but 25 years is the most common.
Mortgage repayments usually include two elements; repayment of the
loan, called the capital, and repayment of the interest on the loan.

Since the late 1980s,
securitisation of mortgages has meant that mortgage debt has been
repackaged to provide a flow of income to third parties, including
investment banks. This approach has been deeply implicated in the
global financial crisis
of 2008-09.

With privately rented property, the landlord
rents out property through a short tenancy agreement, usually for 6
months, though this can be renewed. Tenants typically pay a monthly rent,
though other payment periods may exist.

In the case of local authority rented
property, tenants pay a weekly or monthly rent, which is commonly
subsidised, and below commercial market rates. Property is
allocated to individuals based on need and not just their income. Most
local authorities do not have sufficient properties to meet demand and
have long waiting lists.

New built houses and existing property

The housing market is unlike many other markets
given the relative importance of second-hand transactions, compared
with purchases of newly built property. According to the UK's
largest mortgage lender, the
Nationwide Building Society, only around 5% of transactions
involve the purchase of new properties. Indeed, 95% of transactions
involve the purchase of either 'old' property, which is defined as
property built before the start of the Second World War, or 'modern'
property, which is property built after 1945. The relative dearth
of new property is one of the key factors driving the upward trend
of UK property prices in the long
run.

The importance of the housing market

The housing market in the UK is extremely important for
two main reasons.

Firstly, housing usually represents a household’s biggest single
purchase, and a house represents the largest single item of consumer
wealth.

Secondly, changes in house prices can have considerable effects on the
rest of the economy.

A change in house prices affects the value of
household wealth, creating a positive or negative
wealth effect.
A positive wealth effect means that, following a rise in house prices,
the ratio of the market value of the property to the debt on that
property, typically in the form of a mortgage, rises creating an
increase in equity. This can trigger housingequity withdrawal
(previously called mortgage equity withdrawal) and can be a
significant boost to consumer spending.

Changes in
interest rates,
which are a key policy tool to regulate the UK economy, often have a
more significant effect on consumer spending in the UK than in other
economies. This is due to the relatively large proportion of home
ownership in the UK, and the general spending sensitivity of UK
consumers to interest rate changes.

The long-term trend for UK
house
prices is upwards, but changes in house prices are extremely cyclical.

Property prices, debt and equity

While the debt on properties falls
over time, as repayments are made,
property prices tend to rise. This means that an owner’s equity in
their property also rises. Equity is the difference between the market price of a property
and the debt owed at a point in time.

Housing equity

Rising equity creates a positive wealth
effect, which can lead to housing equity withdrawal. This occurs when
homeowners release some of their equity by taking out a bank loan
secured against the equity in the property.

Recent changes in housing equity withdrawal

Mortgage equity withdrawal

A negative wealth effect is created when house prices fall
creating a fall in equity. Prices may even fall to a level that
creates negative equity, as in the crashes of 1990 and 2008.
Negative equity exists whenever the amount of debt on a property is greater
than the market value of the property. Negative equity reduces
consumer confidence, and is likely to discourage spending.

Demand for private housing

The demand for private housing is determined by a number of
factors, including house prices.

As expected,
there tends to be an inverse relationship between house prices and
demand. As with all goods, the inverse relationship can be explained
with reference to the income and substitution effect.

At higher prices, real incomes will fall and
individuals will reduce their demand. In addition, at higher prices, the
alternatives to owning a property, such as renting, appear more
attractive and individuals are more likely to
rent. When house prices are lower the reverse is true, with individuals
encouraged to buy because of a rise in their real income and because
renting seems less attractive. However, the demand for
property is also partly speculative, so that a rise in prices can
lead to a rise in demand as buyers anticipate a speculative gain.

The non-price determinants include:

In addition to changes in price, which cause a
movement along the demand curve for housing, other non-price factors
are also important, and changes in these cause a shift in the demand
curve.

Population

Total demand for property is determined by
population size and changes in the structure of the population caused by
migration and long-term changes in the birth and death rates. An aging
population will increase the overall demand for property.

Incomes of households

Changes in both the level of national income, and
its distribution, can have a significant effect on the demand for
property. As houses are normal goods with a high income elasticity of
demand, increases in income can trigger a larger percentage increase in
demand. As their income rises many individuals switch from renting to
home ownership, or move to bigger property. Some may buy a second
property as holiday homes, or to rent out. Hence, the demand curve for
private housing will shift to the right as incomes rise.

Social trends

Social and lifestyle trends, such as a
preference for late marriages, can alter the pattern of demand for
houses, and the total demand. The preference for later marriages had led
to an increase in the number of single households, and to a rise in the
demand for flats and apartments.

Interest rates

Changes in general interest rates may be
passed on by lenders such a building societies and banks, and this will
also the amount of monthly repayments for those on variable-rate
mortgages. Higher rates make property less affordable, and the demand
curve will shift to the left.

Recent UK interest rates

Interest rates

Interest rates have been low in recent years,
averaging around 4.5%, which has made property more affordable, and boosting
demand. Rates started to fall dramatically in late 2008, to reach their lowest
level on record. However, mortgage rates did not fall so
dramatically, as lenders looked to maintain their liquidity and
increase their profitability, and because many borrowers were on
fixed-rate mortgages, not all could take advantage of low
rates.

Availability of credit

The availability of credit is also
important in determining the demand for property. During the banking and
financial crisis
of 2008-09, the supply of credit fell which reduced the demand for
housing, and led to a fall in house prices.

UK supply of loans for homes

FusionCharts

Fashion

Owning property has become increasingly
fashionable in the UK over the last 25 years. One reason is the
number of television programmes featuring property purchases,
renovations, and 'make-overs', which have all increased interest in
housing and the housing market.

Price of substitutes

Renting property is an alternative to ownership,
and changes in rental prices can affect the demand for private property.

Buy-to-let demand

The increase in the
availability and popularity of buy-to-let mortgages in the 1990s created a new
market for property as an investment and gave a boost to an already
buoyant market.

Expectations

There
is an important speculative element in the demand for property. Property
developers and ordinary householders often base their current demand
for property on expectations of future price changes. Rising house
prices encourage speculation and falling house prices discourage
speculative buying.

Changes in demand

Changes in any of the underlying determinants of
demand for houses will shift the demand curve to the left or right.

The supply of private housing

Price

The supply of private housing is
partly determined by house prices, together with a number of
underlying determinants. In terms of house prices, the
relationship between supply and price is positive, with higher prices
encouraging supply. Rising prices encourage house builders to construct
more housing, and existing owners are encouraged to sell.

The supply of housing is positively related
to house prices, and the supply curve is upward sloping. However, supply
is frequently inelastic because of time lags and legal complexities and,
in the case of new-builds, because of the difficulty of obtaining
planning permission.

Non-price factors

A change in house prices will lead to a movement along the existing supply
curve for property. Other, non-price factors will cause a shift in the supply
curve.

Availability of factors

As indicated, new house building depends upon
the availability of land, which may be very limited in the short run. An
increase in the availability of land will shift the supply curve to the
right. Availability of labour is also important. For
example, a shortage of bricklayers would reduce the supply of new
houses.

Costs

In the case of new-builds, building costs may
also have a significant effect on supply. These costs include raw
materials and labour costs. A shortage of labour, for example, could
push up the wage rate and increase building costs, which would cause the
supply curve to shift to the left.

Government legislation

Legislation can also affect the supply of
housing in a number of ways. The strict requirement for planning
permission for new house building may deter house builders. Conversely,
relaxation of regulations, as happened in the London Docklands, is
likely to encourage building. Government can also tighten or relax
restrictions on building in rural areas, such as the green belt.

More recently, the UK government
introduced Home Information Packs (HIPS) in an attempt to speed up
the house-buying process. However, critics argue that it has added a
new layer of bureaucracy into an already over-regulated market.

Subsidies

Subsidies given to house builders are also
likely to encourage supply, such as the subsidies given to builders of
‘affordable’ homes for key workers, including police, fire, and
ambulance workers.

Technology

The application of new building methods, such
as ‘pre-fabrication’, and the use of new building materials have increased the speed at
which new houses are built, and hence increased the supply of property.
This has tended to increase the elasticity of supply of properties at
the cheaper end of the market.

Shifts in supply

Changes in an underlying determinant of supply
will shift the supply curve.

Equilibrium house prices

House price reflect both demand and supply,
and, as in all markets, equilibrium price will occur at the price that
matches current demand to available supply. In the short run,
supply is relatively inelastic given that it takes a long time to build
new houses. Hence, increases in demand have an especially
big effect on house prices.

Over time, demand for housing in the UK
has risen continuously while the supply has remained stable. UK
house building in recent years has been one of the lowest in Europe,
and this has contributed to the rising level of average prices.

House prices and interest rates

Interest rates are an increasingly important
determinant of the demand for housing. A small fall in interest rates
can trigger a large increase in the demand for property. Lower interest
rates lead to lower mortgage rates, and encourage new entrants as well
people looking to buy second homes as an investment.

With low interest rates, people with excess funds to
invest will get a better rate of return by investing in property rather
than from a bank deposit account. This additional demand drives up house
prices.